The new land of opportunity: China 2.0

China is reinventing itself - to become stronger and more efficient. That means some spectacular years ahead for investors, says Lars Henriksson.

Google, Facebook, Apple it's not hard to reel off a list of fast growing American tech companies. That might be why many Americans believe they will continue to dominate the world in technology-related sectors. But I think that belief is very short sighted indeed.

Because as China and Asean (the Association of Southeast Asian Nations) members bump up their expenditure on science and technology, many in the Western world are missing out on some landmark developments in Asia. And there was one deal in particular last week that really caught my eye.

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This was a strategic partnership between a bank and a tech company in China. But there is so much more to this story than that.

I think this deal points a whole new means of development for China. It's a story of private industry driving development in China with technology and private industry connecting consumers and channelling credit where it is most needed to sustain Chinese growth. It all involves a company called Alibaba.

Alibaba and booming Chinese e-commerce

Alibaba is the largest e-commerce company in China. It's sort of China's answer to Amazon. You can pick up electrical items, clothes and even some fresh fish. And it is absolutely thriving at the moment.

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Over 500 million Chinese consumers are registered on Alibaba's two online market places, helping the company to generate a total gross merchandise value of 1trn ($163bn) for the first 11 months in 2012. But Alibaba Group chief strategy officer Zeng Ming stated that Alibaba aims to triple that over next five to seven years.

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That growth looks feasible as JP Morgan estimates the Chinese e-commerce market has hit 9% of total retail sales (excluding auto and petroleum sales). In the US, the penetration rate is 10-11%, but what is staggering is that it has taken China just around 3.5 years to jump from 2% e-commerce penetration to 9%. In the US this took ten years to achieve.

Growth in e-commerce will continue, fuelled by mobile web, social networking innovation driving a richer shopping experience online. The news this morning is that Alibaba is looking to expand its operations by pursuing a listing on the US market.

But the deal that really interests is one that happened last week

Because last week China Minsheng Bank (1988 HK), the ninth largest bank in China in terms of loans and deposits, struck up a strategic partnership agreement with Alibaba. It follows a State Council initiative to let the private sector set up banks in China. In fact a number of major internet players such as Alibaba, JD (360Buy), Suning and Tencent immediately applied for banking licences in recent months.

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The new deal suggests that a race to penetrate the banking sector is in full swing. BoA Merrill-Lynch estimates that the China Minsheng Bank will benefit from vast new distribution of its products through Alibaba. They reckon the bank will be able to tap a vast new network of depositors - providing loans and other services to Alibaba's small-medium enterprises.

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What's in it for Alibaba?

Alibaba is entering banking for the same reason Tesco did it in the noughties: to capture profit from millions of loyal consumers and take away some of the easy profit from the high street banks. The risk should be very small as Alibaba is likely to act as the conduit between the bank and the customer, and any risk will be carried by the former. Alibaba can do it cheaper and allow people to get more choices, which is likely to mean more competition within the banking sector, and, in the long-term, improved pricing of capital.

Four reasons this deal is important

So, what can we learn from this potential partnership? Well, I see four main implications.

1. Smarter use of capital in China

China's stupendous growth over the last two decades has been led by state-controlled banks and bureaucrats, resulting in a lot of bridges, townships and projects going ahead with little or no consideration of long-term profitability. With increased private participation, particularly from leading entrepreneurs in the internet sector, we could see a far better allocation of capital across China. In fact this is a critical development for China. Without a better allocation of capital, China's growth will only slow.

2. Increased competition from Asia

On 12 September, the European Commission announced its Connected Continent' proposal, which is set to abolish mobile phone roaming charges and improve broadband and quality of services across the EU. The European Commissioner says that "fixing the telecoms sector is no longer about this one sector, but about supporting the sustainable development of all sectors".

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But according to an analysis by BNP Paribas the proposal still won't make the EU competitive with Asia and America in terms of scale and innovation. Some Chinese network operators, social media and e-commerce companies already dwarf the entire EU in critical mass, and with an increased budget to spend on technology this year, that gap could widen further.

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I think it is fair to assume that a majority of the next two billion smartphones will be sold in emerging markets, and companies with scale and ability to innovate there will be the winners. As the dominant player, China Mobile (941 HK) will benefit from the surge in data volume and connectivity required from consumers and enterprises. It is ready to launch 4G in a few months, which is expected to allow it one or two-years lead ahead of competitors in the new 4G cycle. The stock is trading at a price/earnings ratio of 10.9 times full 2013 earnings, and a dividend yield of 3.9%, according to Bloomberg consensus.

3. Connectivity boosts productivity

According to BNP Paribas, a great deal of "the GDP growth, business development and entrepreneurship that pulled Asia out of the financial crisis in 1998 was significantly related to broadband internet investment and adoption by the masses." And I think the Alibaba and China Minsheng deal as well as the other private banking deals announced is indicative of how private industry can address serious imbalances in the economy. And when you combine healthy consumer lending with improved connectivity through broadband you can seriously boost productivity in this region.

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For instance in July, Myanmar awarded two mobile phone licences to Telenor and Qatar Telecom. The former aims to cover 60% of the population in the first year before rising past 95% within five years.

What is thrilling is that this is supported by a boost in physical connectivity (roads, railways, airports etc) taking place in the Asean area, coinciding with the Asean Free Trade Area in 2015 (AFTA 2105'). In the past I've pointed to several stocks that could benefit from this growing connectivity including Cebu Air (CEB.PS), Italian-Thai Development (ITD: TB) and UEM Sunrise (ULHB: KL).

4. Don't write off China

Alibaba could soon be listed in New York in what could be the biggest listing in the technology sector since Facebook. I think it will allow sceptical investors to have a fresh look at the fundamentals of the China story.

Now there are undoubtedly a number of deep-seated problems in the Chinese economy. You could point to the bloated banking sector, stubbornly high property prices and concerns about rising living costs. But that is more or less known.

What is less known is that China is being reconfigured in a way that will allow it to become stronger and more efficient in the future. One very good example was the new kind of special economic zone that will be launched in Shanghai next week. I think there is a new China on the horizon. And if foreign investors start to warm up to these changes, we might see a reversal of the gloomy outlook for Asia that hangs over these markets right now.

Because everything that I'm seeing on the ground here in Southeast Asia contradicts the attitude that Western investors have to this region. I see a lot of fear and a lot of panic. And that makes me all the more confident that my investments are poised for a spectacular few years ahead.